15 January 2010

SEC proposes rule to reduce market access risks

The SEC is proposing a new rule which would effectively prohibit broker-dealers from providing customers with "unfiltered" access to the markets. It is also calling for comment on issues relating to high-frequency trading, co-locating trading terminals and dark pool trading.

The SEC has proposed a new rule that would effectively prohibit broker-dealers from providing customers with "unfiltered" access to the markets. It also called for comment on issues relating to high-frequency trading, co-locating trading terminals and dark pool trading as it seeks to re-write the rule-book for a new era of computer-driven trading.

 

The SEC's proposed rule would require brokers with market access, including those who sponsor customers' access to an exchange, to put in place risk management controls and supervisory procedures.

 

"Unfiltered access is similar to giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied," said SEC Chairman Mary Schapiro. "Today's proposal would require that if a broker-dealer is going to loan his keys, he must not only remain in the car, but he must also see to it that the person driving observes the rules before the car is ever put into drive."

 

However, those laws and rules do not apply to a non-broker-dealer customer who a broker-dealer provides with their MPID in order to individually gain access to an exchange or ATS.

 

The SEC's proposed rule would require broker-dealers to establish, document and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks related to its market access, including access on behalf of sponsored customers.

 

Broker-dealers would be required to:

Ø       Create financial risk management controls reasonably designed to prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous.

Ø       Create regulatory risk management controls reasonably designed to ensure compliance with all regulatory requirements applicable in connection with market access.

Ø       Have financial and regulatory risk management controls applied automatically on a pre-trade basis before orders route to an exchange or ATS.

Ø       Maintain risk management controls and supervisory procedures under the direct and exclusive control of the broker-dealer with market access.

Ø       Establish, document and maintain a system for regularly reviewing the effectiveness of its risk management controls and for promptly addressing any issues.

 

The SEC today also approved a new Nasdaq rule that requires broker-dealers offering sponsored access to Nasdaq to establish certain controls over the financial and regulatory risks of that activity. The proposed Commission rule would extend beyond the new Nasdaq rule in several respects.

 

Concept release for comment:

 

The concept release requests comment on all matters related to market structure. In addition, it asks many specific questions about the current market structure, including:

 

Market Quality Metrics

       What are the best metrics for assessing market quality for long-term investors and have these metrics improved or worsened in recent years?

 

Fairness of Market Structure

       Is the current highly automated, high-speed market structure fundamentally fair for investors?

 

High Frequency Trading

       What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?

       Is the overall use of any harmful strategies by proprietary firms sufficiently widespread that the Commission should consider a regulatory initiative in this area?

 

Co-Location

       Do co-location services (which enable exchange customers to potentially route trades faster by placing their computer servers in close proximity to an exchange's computer system) give proprietary trading firms an unfair advantage?

       If so, should the proprietary firms that use these services be subject to any specific trading obligations?

 

Dark Liquidity

       Has the trading volume of undisplayed trading centers (such as dark pools) reached a sufficiently significant level that it has detracted from the quality of public price discovery?

       If more individual investor orders were routed to public markets, would it promote quote competition in the public markets, lead to narrower spreads, and ultimately improve order execution quality for individual investors beyond current levels?

       Are a significant number of individual investor orders executed in dark pools and, if so, what is the execution quality for these orders?

 

Press release

Concept release issued for comment

 

© SEC